UniCredit Bombshell Shouldn’t Be the Last One: Jonathan Weil

Nov. 17 (Bloomberg) -- Everyone in the world who pays any
attention to the financial markets seems to know that the
balance sheets of European banks are a joke. All you have to do
is compare the stock prices of these companies with the book
values on their balance sheets to see that.

On average the shares of the 32 companies in the Euro Stoxx
Banks Index trade for about 44 percent of book value, or common
shareholder equity, according to data compiled by Bloomberg. Put
another way, a typical large euro-area bank would have us
believe its net assets are worth more than twice what the stock
market says the bank is worth. The problem is the companies’
numbers can’t be trusted, and it’s been this way for years.

So imagine the surprise this week when UniCredit SpA, one
of Italy’s largest lenders, had the fortitude to acknowledge
that its asset values were in need of an 11-figure chopping. The
truly unexpected part wasn’t that the bank experienced a loss of
10.6 billion euros ($14.3 billion) during the third quarter, but
that its management chose to recognize these losses’ existence.

No other company in the index has reported anywhere near
that much red ink for the third quarter. Most showed quarterly
profits. The next-biggest net loss, at Belgium’s KBC Groep NV,
was 1.6 billion euros.

Yet even after its recent confession, UniCredit’s shares
still trade for just 28 percent of book value. On its balance
sheet the company showed shareholder equity of 52.3 billion
euros as of Sept. 30. At 75 cents a share, meanwhile, the
company’s stock-market value is a mere 14.5 billion euros.

Useless Assets

It’s easy to see why the discount is so big. About 12
billion euros, or 23 percent, of UniCredit’s equity consisted of
deferred-tax assets. Basically, this number represents the money
UniCredit believes it will save on taxes in the future, assuming
it will be profitable. Trouble is, in a crisis, those assets are
pretty much useless.

On top of that, UniCredit’s balance sheet still showed 11.5
billion euros of the intangible asset known as goodwill, even
after the bank wrote this down by 8.7 billion euros last
quarter. Goodwill isn’t a salable asset. It’s the ledger entry a
company records when it pays a premium price to buy another. The
asset exists only on paper. (For what it’s worth, European banks
are allowed to count deferred-tax assets as part of their
regulatory capital, unlike goodwill.)

Add up the goodwill and deferred taxes, and that’s 23.5
billion euros of junk assets right there, which is more than the
company’s market capitalization.

Hence, the problem: The numbers don’t make sense, at least
not in the real world. And this is from a bank that would seem
to be a beacon of candor by European standards, considering that
no one else reported such huge third-quarter losses at a time
when Europe is on the verge of disaster.

The French lender Credit Agricole SA, for instance, showed
19 billion euros of goodwill as of Sept. 30. That’s 7.4 billion
euros more than its current market cap. Dexia SA, the French-Belgian lender, took a government bailout in October, only three
months after passing European regulators’ stress tests. Lack of
faith in big banks’ numbers isn’t strictly a European problem,
either. In the U.S., Bank of America Corp. shows $70.8 billion
of goodwill, about $11 billion more than its market cap.

There’s no secret about the banks’ predicament. Were they
to get aggressive about taking losses and raising fresh equity,
investors might worry they’re in grave danger. If they don’t get
aggressive enough, the markets will conclude their numbers
aren’t credible, in which case they may blow up anyway.

UniCredit seems to be staking out some sort of middle
ground, only the markets are saying it’s not enough. This week
the company said it plans to raise as much as 7.5 billion euros
of capital by selling stock. That’s a drop in the bucket for a
bank showing 950 billion euros of assets.

Sure, we can all hope the banks muddle through long enough
for Europe’s leaders to come up with a solution to the region’s
debt crisis somehow, as unlikely an outcome as that seems. Yet
the longer this game of delay-and-pray goes on, the worse the
problems will get.

UniCredit can’t possibly be the only lender in Europe that
has incurred such huge losses. And the markets are telling us
its losses are probably even bigger than what the company has
disclosed. Maybe next year will be when the banking industry’s
real bombshells drop.

(Jonathan Weil is a Bloomberg View columnist. The opinions
expressed are his own.)